The United States: A New China Alternative?

Nov. 3 – China is gradually shifting away from its position as the world’s default production base for manufacturers. In this country, factor costs are surging and government incentives for foreign investors are diminishing, forcing more and more companies to seek new and attractive destinations where they can relocate their factories. While emerging Asian countries boasting low overhead costs – such as India, Vietnam, Thailand and Indonesia – are undoubtedly attracting mounting attention, the United States is also growing back into an increasingly reasonable option for manufacturing, according to an intensive study conducted by the U.S.-based advisory firm The Boston Consulting Group (BCG).

The BCG report, which suggests manufacturers take “a hard, fresh look” at the United States, pointed out that China’s manufacturing cost advantage over the United States is shrinking fast due to Chinese labor becoming more expensive and local currency gaining value while productivity is not catching up as rapidly. When making their investment decisions, investors should take total costs – rather than only labor costs – into consideration and choose manufacturing locations based on product-by-product analyses.

Labor cost
While China’s cheap labor force used to be the country’s major advantage attracting foreign manufacturers, it is not exactly the same story today. Although starting at a low base, wage levels in China have been skyrocketing over the last decade. Between 2000 and 2005, compensation packages for Chinese factory workers rose by 10 percent annually on average, and from 2006 through 2010, the annual wage growth rate accelerated by an average of 19 percent. In contrast, total pay and benefits for U.S. production workers over the past five years only increased by 4 percent a year.

China’s legal system for labor rights protection is also growing stronger, with the Labor Force Law and Employment Contract Law enacted in 1995 and 2008, respectively. Employers have no option but to increase payrolls, not only because Chinese labor organizations are gaining a greater ability to demand higher wages, but also because the legal requirement for additional benefits – such as mandatory social welfare and worker severance compensation – has added to the total labor cost. In 2010 alone, minimum wages across China increased by around 20 percent to 30 percent, and a company’s social welfare expenses could be as high as 37 percent on top of the salaries paid to employees. Furthermore, with foreign employees now to be included into the country’s social insurance scheme and with a potential removal of the cap on social welfare contributions looming on the horizon, China is growing more and more distant from the low-cost option it once was.

China’s rising labor costs are also being spurred on by the increasing scarcity of production workers. With living costs surging in many of the country’s coastal cities, an increasing amount of young people no longer find it an economic option to work for manufacturing companies in those regions. A recent commentary on the Financial Times predicted that the supply of young workers in the industry is set to drop by roughly one-third between 2010 and 2022.

BCG research projects that the labor cost gap between China and the United States will grow even smaller over the next five years. The fully-loaded cost of workers in the Yangtze River Delta – the region with the highest manufacturing output in China – will grow by an annual rate of 18 percent to about US$6.31 per hour. Such wage levels will be equal to around 25 percent of the salary earned by skilled workers in the manufacturing states of the southern United States, while the pay gap was as large as 1:25 only 10 years ago.

Other costs
Labor is not the only thing that is getting more expensive in China. A variety of factors that are vital for manufacturing – including land prices, transportation costs and tax payments – are also becoming more costly.

Along with the boom in China’s real estate development, industrial lands in some Chinese cities are even more expensive than those in the United States. According to the BCG study, the national average price of industrial land in China has reached US$10.22 per square foot, with prices in some coastal cities such as Shanghai and Shenzhen exceeding US$15 per square foot. In comparison, industrial lands in some particular states of America – such as Alabama, Tennessee and North Carolina – are much cheaper at prices ranging between US$1.3 to US$7.43 per square foot.

Costs relating to national and international transportation are also gaining significantly. Manufacturers – who are driven to relocate their plants to inland China due to high land prices in coastal cities – may find they end up spending more on national transportation; at the same time, trans-Pacific shipping rates have also increased as a result of surging fuel prices, making many investors reconsider the cost-effectiveness of outsourcing manufacturing to China.

Foreign companies in China have also been complaining about the heavy tax burden, especially after the central government cancelled most of its tax incentives to foreign investors last year. A report by Forbes back in 2009 suggested that China’s tax burden was the second highest in the world, and a recent commentary by China Briefing estimated the total tax burden for foreign companies may be even higher now, with the raised minimum wages and introduction of social welfare payments for foreigners.

Investors also find there are additional expenses and risks to extend their supply chains to China. They may need to spend more on inventory, encounter difficulty in quality control, face supply disruptions due to port closures or natural disasters, and gain concerns about intellectual property theft and trade disputes that result in punitive duties.

Productivity
Productivity of China-based manufacturing has improved fast by an average of 10 percent every year over the past decade, but not fast enough to catch up with its rising labor costs. The BCG study forecasts that, over the next five years, output per worker in China will grow at only half the pace of the increases in wages, which indicates that productivity-adjusted costs in the country are rising in general.

The reports also specifically pointed out that automation and other measures to advance productivity in China will not be enough to preserve the country’s cost advantage. Instead, they will undercut the access to cheap labor, which is the primary attraction of outsourcing to China.

The picture of a U.S. manufacturing renaissance
China’s diminishing manufacturing advantages do not mean the tide of manufacturing outsourcing will be completely reversed, but it is more of a heads-up for investors so that they take various factors into account when choosing locations for their production bases.

The BCG report indicated that labor-intensive industries will be more likely to remain in China (or be relocated to other emerging countries with even lower labor costs), while industries that are more technology-intensive – such as transportation goods, electronics, fabricated metal products, machinery, plastics and rubber, electrical appliances and furniture – will more likely start returning to the United States.

In addition, the potential manufacturing renaissance in the United States does not necessarily mean a large-scale withdrawal of investment from China. With the expanding domestic demand in China and shrinking cost gap between China and the United States, there is a growing need among manufacturers to locate their factories in both countries so that they can be more devoted in serving each individual regional market.

The China AlternativeOur complete series on other manufacturing destinations in Asia that are now starting to compete with China in terms of labor costs, infrastructure and operational capacity.

China’s Social Insurance LawA summary of some of the key points in the newly implemented Social Insurance Law, which covers a great deal more than just incorporating foreigners into the system. We explain the costs and benefits of participation by foreign employees to both companies and individuals as well as take a look at some of the trends across the country relating to the implementation of the law.

Developing Your Business from China to India and VietnamOur complimentary 25-page PDF report detailing cost analysis, labor and factory overheads comparisons between Dongguan, Chennai and Ho Chi Minh City, as well as an overview of other emerging Asian markets such as Cambodia and Laos. It includes full factory cost analysis, descriptions of the legal establishment differences and options, the tax implications in these markets, as well as business and cultural differences. This is a must read for all executives interested in expanding into Asia.

If the business isn’t related to the inner China market, better move as soon as possible.
When somebody made in comparison the labor costs, necessary understand the single output and performance for worker .Actually medium production labor costs /unit it’smore higher than the East Europe.

If the USA are one target market, no doubt at all.

The local tax office asking to us, the forecast about how much vat We will pay until the end of the year. No rule, no safety, no guarantee.

Meet the firm behind our content. Dezan Shira & Associates have been servicing foreign investors in China, India and the ASEAN region since 1992. Click here to visit their professional services website and discover how they can help your business succeed in Asia.

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